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STEC Gets Decked by a Double-Edged Sword

Enterprise customers are a blessing and a curse for this storage specialist. Right now, it's nothing but curses.

STEC(Nasdaq: STEC) blazes a trail in making solid-state drives for enterprise applications. The growth potential is nearly limitless as SSD storage is still in its infancy -- but nobody ever said it would be easy.

STEC's stock (say that five times fast) plunged as much as 15% on last night's first-quarter report. The company lost $0.17 per share on $50.4 million in revenue, barely edging out Wall Street's sales target but missing on the bottom line. If that mixed bag weren't disappointing enough, management followed up with revenue guidance for the next quarter some 20% below the Street view. Bottom-line losses should be steeped in at least twice as much red ink as the current consensus indicates.

CEO Manouch Moshayedhi says this is a temporary problem. A number of expected sales were pushed back as the customers needed more time to test STEC's storage products. "Until qualifications are completed, we cannot accurately project the sales of these products," Moshayedhi said. He also believes that the second quarter will mark the very bottom of this negative cycle.

STEC's enterprise focus is a double-edged sword. On the upside, large data-center customers tend to place huge orders, and when times are good, they can be very good indeed. What we see here is the negative flipside of that coin, where the enterprise-grade business requirements lead to higher-quality needs and these excruciatingly slow qualification processes.

Management expects STEC to be profitable when revenue exceeds $65 million per quarter. That would take almost a 60% rebound from next quarter's guided sales, and that's not an easy trick to pull off. STEC shares never recovered from the 39% dive they took last summer, when management admitted that customers wanted cheaper storage than it could produce.

The market is taking this report as a sign that STEC is losing market share. Direct competitor OCZ Technology(Nasdaq: OCZ) saw its shares jumping 12% on the news, erasing the market-cap damage from OCZ's own disappointing report last week. That theory makes perfect sense if OCZ can sell high-quality SSD devices at a discount to STEC's products. And OCZ makes some of the parts for its end-user drives in-house while STEC doesn't. There are cost savings to reap in that integrated business model.

STEC could be a tremendous value here if the company can make good on its promises of rising revenue and renewed profits. But talk is cheap. I have bullish CAPScalls on both OCZ and STEC right now, but I feel considerably more comfortable about the OCZ play. This is probably not the next rule-breaking multibagger.